SEATTLE EXEC. SERV. DEPT. v. Visio Corp.
| Decision Date | 24 September 2001 |
| Docket Number | No. 47649-1-I.,47649-1-I. |
| Citation | 31 P.3d 740,108 Wash. App. 566 |
| Parties | CITY OF SEATTLE, EXECUTIVE SERVICES DEPARTMENT, Appellant, v. VISIO CORPORATION, Respondent. |
| Court | Washington Court of Appeals |
Cynthia Seu, Seattle, for Appellant.
Robert Mitchell, Preston, Gates & Ellis, Lance Behnke, Seattle, for Respondent.
The City of Seattle, Executive Services Department ("the Department") appeals a Hearing Examiner's conclusion that it was collaterally estopped from litigating the merits of a business and occupation ("B & O") tax assessment against Visio Corporation, a software company. The Examiner applied collateral estoppel based on an earlier superior court case involving a similar software company that presented the same issue as the challenged assessment here: whether the production of software code constitutes "manufacturing" as defined in former SMC 5.44.028(4). The Examiner also decided not to consider the Department's alternative taxation theory because the record did not support that theory and the original assessment was based on a different ground. We affirm the Examiner's decision.
Visio developed and licensed three core products during the audit period: Visio Standard (basic business diagramming software), Visio Technical (enhanced diagramming and drawing software for technical professionals like engineers and architects), and Visio Professional (enhanced diagramming and drawing software for information systems and information technology professionals). These products were released in November 1992, December 1994, and January 1997, respectively. During the final months of the audit period, Visio released Visio IntelliCAD 3D (a computer aided design application). In addition to these core programs, Visio developed and released certain add-on software for use with its core products, including Visio Network Equipment, an add-on solution for the design and documentation of local, wide-area and telecommunications networks.
Visio produced the code for these software programs in Seattle and hired third-party contractors outside Seattle to transform the code into boxed software products for distribution to end users. Visio assigned a member of its staff to supervise the contractors' work and furnished the contractors with electronic artwork, packaging and materials specifications, and software code. The code was delivered to the contractors on a floppy disk or a CD, and they used the code to create software CDs. The contractors then put the CDs in plastic cases for protection and printed the user manuals, documentation, and boxes for the software. They assembled the CDs, manuals and documentation, placed these items in boxes, and shrink-wrapped the boxes. The contractors stored or warehoused an inventory of Visio's boxed software on their premises, shipped the software to Visio's customers according to instructions from Visio or its designee, and sent Visio an invoice when the software was shipped. No boxed software inventory was maintained in Seattle. Throughout the audit period, Visio's contractors conducted all activities under their agreements with Visio entirely outside Seattle.
In 1998 the Department audited Visio and on December 21, 1998, issued a $435,652.82 B & O tax assessment.1 The assessment classified Visio's production of prewritten software in Seattle as manufacturing according to Seattle Rule 5-44-155 and SMC 5.44.400(B). Rule 5-44-155 explains the proper application of B & O taxes to "[p]ersons rendering information or computer services and persons who manufacture, develop, process, or sell information or computer programs[.]"2 It designates two classes of software—"prewritten" and "custom"—and taxes software production and licensing differently depending on the class. A "prewritten" program is "software which is not originally developed and produced for the user,"3 while a "custom" program is "software which is developed and produced by a provider exclusively for a specific user, and which is of an original, one-of-a-kind nature."4 The Rule deems sales of prewritten software as sales of tangible property: "[T]he sale, lease, or licensing of the computer program is a sale or lease of a product, even though produced through a computer system or process" because sales of "[s]tandard prewritten software programs ... are essentially sales of articles of tangible personal property."5
Because Rule 155 characterizes prewritten software as tangible personal property, it taxes licensing prewritten software as retailing or wholesaling and production of prewritten software as manufacturing.6 At the time of the assessment, the Seattle Municipal Code defined "manufacturing" as follows:
"To manufacture" embraces all activities of a commercial nature wherein labor or skill is applied, by hand or machinery, to materials so that as a result thereof a new, different or useful article of tangible personal property or substance of trade or commerce is produced[.][7]
Visio filed a timely appeal of the assessment with the Seattle Hearing Examiner on January 11, 1999.
While Visio's case was pending with the Hearing Examiner, and before it had been briefed or argued, the King County Superior Court decided Walker Richer & Quinn, Inc. v. City of Seattle8 ("WRQ"). That case involved a B & O "manufacturing" assessment identical to the one imposed on Visio for developing software code within Seattle. WRQ alleged that Rule 155's classification of producing a software program as manufacturing was inconsistent with the definition of manufacturing in former SMC 5.44.028(4), quoted above. The trial judge observed: "The Court must therefore determine for itself the legal issue of whether an administrative rule which purports to subject to B & O tax persons who prepare pre-written software in Seattle is within the policy of the ordinances at issue."
The parties to this case agree that the facts in WRQ are identical to those in this case. Like Visio, WRQ is a company that develops, sells, and services computer software that connects personal computers to mainframe computer systems. Its activities in Seattle include research and development of software, sales, marketing, and management. Some of these activities do not result in a product, but for other activities WRQ produces a "master disk" containing code. WRQ sends the master disk to Quebecor in Fife. Quebecor produces the floppy disks or CDs for sale to consumers and warehouses the finished products. Quebecor also ships the finished products to customers directly from the Fife facility.
The trial court determined that WRQ was not a "manufacturer" for purposes of Seattle's B & O taxes, holding that Rule 155 under which a Hearing Examiner had found WRQ was a manufacturer, was inconsistent with the definition of manufacturing activity in SMC 5.44.028(4). The court noted that the meaning of "materials" in the context of the City tax code and consistent with its ordinary dictionary definition, is "that the materials at issue must be of a physical or worldly nature, as opposed to an intellectual or spiritual nature." The court concluded that "[t]he initial writing and recording of intellectual or creative activity cannot reasonably be deemed to be the transformation of physical materials by labor or skill[.]" Therefore, the court determined, "WRQ is not engaged in the activity of `manufacturing' within the meaning of Seattle Municipal Code, SMC 5.44.028(4)" and the assessment was reversed.
The Department appealed the WRQ ruling to this court. While the appeal was pending, the Seattle City Council deleted the word "materials" from SMC 5.44.028(4)'s definition of manufacturing. The Department later settled the case, and the parties dismissed it by stipulation on December 10, 1999, before an appellate decision was rendered.
In its appeal to the Hearing Examiner, Visio contended the assessment "incorrectly concludes that [Visio's] activities within the city of Seattle are subject to the B & O tax under the manufacturing classification." According to Visio, it does not engage in any activities within Seattle's boundaries that meet the definition of manufacturing in the City tax code before it was amended. The Department responded that Visio's production of software was manufacturing, and even if it was not, the software production was still taxable according to SMC 5.44.400(F), which taxes all business activity in Seattle not otherwise classified.9
The Hearing Examiner ruled that the Department was collaterally estopped from litigating the issue of whether Visio manufactured software in Seattle because the same argument on the same facts was rejected by the Superior Court in WRQ. The Examiner also rejected the Department's argument that Visio was subject to the general business tax, concluding that "[t]he record does not allow such a sweeping conclusion" and "the assessment under appeal is not based on that theory."
The Department brought a writ of review of the Examiner's decision under RCW 7.16 and SMC 5.44.120(D). The trial court affirmed the Examiner's decision and this appeal followed.
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